In re Hill, No. 10-49177; U.S. Bankruptcy Court (DNJ); opinion by Stern, U.S.B.J.; filed August 12, 2013. DDS No. 42-6-xxxx [40 pp.]
In this adversary proceeding, plaintiff Cornelius Floyd moves for partial summary judgment to except a purported $3.2 milllion debt from the bankruptcy discharge of defendant-Chapter 7 debtor Stephen Hill, a licensed investment adviser, pursuant to 11 U.S.C. § 523(a)(19).
At the heart of Floyd's motion is a summary order by the New Jersey Bureau of Securities that made detailed findings regarding the sale of securities for Hackensack Park Plaza and a venture known as "Snap-on-Smile," a dental appliance invention. Floyd purchased securities in these ventures through Hill.
The bureau's investigation concluded that Hill had, inter alia, engaged in dishonest or unethical practices in the securities business. As a result, his investment adviser registrations were revoked and he was assessed a civil penalty. There was no challenge to or appeal from the order.
Before Hill's bankruptcy and the summary order, Floyd had filed suit in the district of New Jersey for federal securities law violations associated with the Hackensack offering and in the Southern District of New York regarding the SOS investment. Both cases were stayed as to Hill when he filed his bankruptcy petition. Thereafter, Floyd filed this action. Only the § 523(a)(19) (federal securities law violations) counts remain at issue, given plaintiff's waiver of trial and complete reliance on his limited summary judgment motion that depends almost exclusively on the summary order and the purported preclusive effect of its factual findings.
The court says there are two issues: (i) does the bankruptcy code provision excepting from discharge a Chapter 7 debtor's debts for securities law violations deny the bankruptcy court authority to enter the initial substantive judgment for those violations? and (ii) assuming the bankruptcy court is authorized to enter that initial substantive judgment, does the summary order, as augmented by summary judgment motion submissions, preclusively establish facts pertinent to Hill's violation of securities law and his debt to plaintiff, as well as that debt's § 523(a)(19) exception to discharge?
Held: The court has authority to adjudicate liability and damages for securities law violations within a § 523(a)(19)-based adversary proceeding. Thus, the summary order's findings of fact are not preclusive in this proceeding. Because neither an extension of the common law via § 523(a)(19) nor traditional common-law issue preclusion is applicable in this case, plaintiff has failed to establish facts necessary to support his summary judgment motion, which is denied. No substantive judgment nor judgment for exception to discharge is to be entered against the debtor.
The court says that § 523(a)(19) in its original form was added to the bankruptcy code as part of the Sarbanes-Oxley Act of 2002. The section was modified in 2005 as part of the broad sweep of bankruptcy code amendments included in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), to include "before, on, or after the date on which the petition was filed." Section 523(a)(19) now provides that there is an exception to discharge for any debt for violation of any federal or state securities laws that results, before, on or after the date on which the petition was filed, from any judgment or order entered in any federal or state judicial or administrative proceeding. The section contains no language limiting the purview of the bankruptcy court. Its legislative history indicates that the provision was intended to make judgments and settlements based on securities law violations nondischargeable, protecting victims' abilities to recover their losses, and to avoid state regulators having to "reprove" their fraud cases in bankruptcy court to prevent discharge.
The court says there is substantial disagreement among courts regarding the substantive area in which the bankruptcy court can adjudicate § 523(a)(19) claims. It says that BAPCPA made it clear that a debtor's race to bankruptcy ahead of a state regulator's determination would not disable the exception to discharge and clarified that once the purported petition date dividing line was removed from § 523(a)(19), there is no contextual, textual or functional justification to bar the bankruptcy court from entering, where appropriate, the judgment in favor of investors coming forward with preclusive regulatory orders.
The court holds that, consistent with Sarbanes-Oxley and BAPCPA, it has the jurisdiction and authority to enter the "resulting" judgment (§ 523(a)(19)(B)(i)) for securities law violations (§ 523(a)(19)(A)), in a wide array of adversary proceedings to except debts from discharge.
The court then turns to the summary order. It notes that Hill was given a notice of right to hearing but did not request one. After setting forth the findings of fact in the summary order, the court finds that plaintiff's assertions regarding the Hackensack Park securities are glaringly weak even if preclusion were to be allowed. Thus, assuming arguendo that the summary order states established facts, those facts, as augmented by motion submissions, are inadequate as a matter of law to prove Hill's Rule 10b-5 violation. Plaintiff has thus failed to put forth a case for summary judgment on this claim.
However, the court says the summary order raises serious questions of Hill's Rule 10b-5 violations involving the SOS securities, including whether Hill, without Floyd's authorization, knowledge or ratification, invested Floyd's funds in those securities. The court therefore considers whether the findings of fact in the order are preclusive in this proceeding.
It reviews the generally applicable law of issue preclusion regarding state administrative orders affecting later federal litigation and cites federal case law holding that when a state agency acting in a judicial capacity resolves disputed issues of fact properly before it, which the parties have had an adequate opportunity to litigate, federal courts must give the agency's fact-finding the same preclusive effect to which it would be entitled in the state's courts. New Jersey's courts have granted preclusive effect to an administrative agency's fact-finding after determining that the body had acted in a judicial capacity.
The court looks to § 523(a)(19)'s effect on preclusion. It concludes that the applicable common law is not affected by Sarbanes-Oxley with respect to the debt claimed to be owed Floyd because the summary order is not the source of that debt.
The court then says Floyd's reliance on the order depends solely on its preclusive effect under New Jersey common law. The court says the order will not be applied preclusively for Floyd's benefit for several reasons. First, New Jersey's requirements for collateral estoppel are not satisfied since, inter alia, the facts sought to be established preclusively were not actually litigated in the investigative process and that process did not satisfy judicial or quasi-judicial requirements, and no final judgment on the merits as to Floyd's claims was rendered. Second, New Jersey's precedent renders the order the product of an investigative administrative process and, prior to the order's issuance, there was no "hearing" and thus no opportunity for representation or confronting of witnesses. Third, New Jersey's securities law limits use of its regulatory enforcement provisions in establishing civil liability to individual investors, thus creating a clear distinction between the bureau's findings and conclusions arising from the investigative/regulatory functions and those investors' civil actions based on nuanced and subjective misrepresentation and omission claims, which impedes Floyd's effort to cast the order as being the result of even a quasi-judicial process.
The court concludes that neither an extension of the common law via § 523(a)(19) nor traditional common-law issue preclusion is applicable and thus plaintiff has failed to establish facts necessary to support his summary judgment motion.
For plaintiff — Barton Nachamie, of the N.Y. bar (Nachamie Spizz Cohen & Serchuk) and Jeffrey L. Rosenberg, of the N.Y. bar (Jeffrey L. Rosenberg & Associates). Debtor-defendants appeared pro se.